Welcome everyone to another edition of the weekly global macro roundup. I struggled a bit this week with my thesis as it seems as if there is a plethora of narratives to choose from.

As my long-time readers know, I just don’t write to write, it has to have meaning, has to have substance and above all else engagement for you, the reader. So, I decided that I would touch briefly on various things and not go too far into any singular issue.

What I want to do first if give you the trading, investment and economic thoughts and then move onto a few other topics that I think are important for you guys to dig further into on your own.

Many studies have shown that by actively engaging in reading and research, you build a cognitive process and this process aides in the development of memory and understanding. That is why I encourage you to be inspired by what I write in hopes you end up doing a bit more reading on the very topics I bring up. Anyway, let’s get to it…

Ok, what’s been circling around the financial sphere’s lately? What seems very obvious to me is that there has been an extreme focus upon the flattening of the U.S. yield curve. As a long time, fixed income basis arb, this outcome is purely fundamental from a hawkish and tightening Federal Reserve.

Yield Curve flattening, which is nothing more than short rates moving faster than long rates for a given interest rate shift and is usually attributed to an expected higher interest rate environment. Now this doesn’t mean the yield curve can’t flatten if interest rates fall, they certainly can, but generally they are of the bear market form.

What do we mean by bear market in interest rates? It means that the prices of bonds are falling and the corresponding interest rate is rising, price and rate are inverse. I have chosen the following chart to display this visually:

The black line represents the current U.S. Treasury yield curve and it is obviously flat, which should seem strange to any investor because it doesn’t make sense to loan someone money for a longer period of time and receive the same interest rate does it?

No, it doesn’t and it shouldn’t, but many forces are in play, wait till we go inverted that will really blow your mind! The blue line represents a “normal” yield curve where the interest rate (%) rises as time (years) rises. This makes more sense, right? Then the red line is clearly an “inverted” yield curve, the alleged holy grail predictor of recessionary times.

I am not sold on that idea of its predictability, rather I believe the inverted curve to be a highly central bank driven construct that is less deterministic and more intrinsic based purely on raising the cost of funding in a highly leveraged system.

So, for me it’s more backward looking than forward. Meaning recessions form because money becomes tight and capital is withdrawn and was exacerbated by the artificial support of interest rates by central banks in the first place.

Any novice can look at the slope of the red line and say, that doesn’t make sense, why would the demand for an interest rates be greater for a shorter period of time? I could simply borrow money at the long end and sell the higher rate at the shorter end and lock in profit! Yes, you could and you would then be an expert bond arb like myself, however, it is not that easy trust me, but the fundamentals of that arbitrage are what eventually brings it back into line!

One thing that most people don’t think of is, counterparty risk, at least they don’t think of it till it’s too late. What risk does the U.S. treasury bond have…plenty and there are reasons why peripheral EU countries pay less for borrowing money then our very own “safety net” U.S. treasury bond!

Those fundamentals however are for another day, a day in the future I am sure, but this should peak your interest as to why and how the cost of money truly affects things. You have been sold the fact that lower interest rates are good for you, they lower the cost of money.

What they haven’t told you is the very fact that investments that come from borrowing are exponentially different from investments that are made with savings.

As a saver would you rather earn 8% on your 1-year T-bill or be able to borrow more money at 1%? The answer should be quite obvious if it isn’t and if it isn’t we highly suggest you continue to watch the U.S. debt pile up and then ask yourself, can the U.S. taxpayer continue to expand their debt obligations while interest rates rise?

Every investor I talk to knows equities, but they rarely follow bonds, which is a mistake. In a debt and fiat monetary system, interest rates and their flip side credit determine aggregate nominal prices.

The system is designed to always increase in price or “inflate.” This phenomenon is most unfortunate for the majority, but extremely fortuitous for a select few.

The problem with a fiat monetary system is debt must constantly expand or else the aggregate price level will collapse.

I believe the price level collapses anyway purely by the weight of the debt that is accumulated. Not only will nominal asset prices fall, but in general the purchasing power of the consumer erodes as well.

Austrian economists call this the “Minsky moment”, named after in my opinion one of the greatest American economists ever, Hyman Minsky.

Maybe I am partial to the fellow Chicagoan, or maybe it’s the fact he was highly critical of Keynes’ neoclassical interpretations, I’ll take either one as admission.

It doesn’t take a genius to figure out that debt can only be sustainable if more and more is created, this type of system is the one we unfortunately adhere to. Will this change?

I believe so and the moment everyone is so desperately trying to avoid will eventually arise, it always does. Here is a great chart from PIMCO:

Perhaps the Central Banks should consult this French poet’s quote in order to learn something:

“A person often meets his destiny on the road he took to avoid it” -Fontaine

With all this in mind, it is no wonder the equity markets have gone nowhere since January. The Federal Reserve continues to raise not because they want to, but because they have to.

They will need room to maneuver for the coming recession and they know rates were way to low causing the elites and corporations to take full leveraged advantage.

The SP500 put in a high back on January 26th at 2872.87 and we haven’t even come close since. The SP500 trades near 2725, some 5% off the highs.

The longer the market fails to even take a clean shot at new highs the greater the odds of a stronger sell off, in fact another trade below 2650 should bring in a host of new sellers.

We must start out this week’s letter, with what may be the most historic moment thus far in terms of president Trump’s tenure as president. There is no doubt in our minds that the United States played a very key role in North Korea’s Kim Jong Un and South Korea’s Moon Jae-in’s meeting at the DMZ in Korea this week. With what is an absolute historic moment as North Korea’s leader set foot over the demarcation line and onto the South Korean side for the very first time. They are currently discussing the prospects of peace and denuclearization, which has probably taken the entire world by surprise. This is an absolute historic moment and we are hopeful that peace does indeed prevail. If the deal is successful we are confident that many will be clamoring for POTUS to win the Nobel Peace Prize.

What never ceases to amaze me about investors is their utter disdain for logical explanations of economic occurrences. It seems to be that logic is often forgone for euphoria, this feeling that “the good times can never end.” Maybe that logic is NOT as widespread or dispersed as I once thought. The older I get the more market experience I have, leads me to believe that investors are perpetually ignorant, and certainly forgetful. I can’t really attribute one specific human trait that perpetuates this theory about investors, but I am sure it’s a whole host of things. However I can safely now, include investment managers into this loop as well. Maybe managers are a bit more arrogant, a bit more complacent to their own inadequacies and that’s what leads them down paths of destruction.

We have talked at length on the sinking Dollar and at Davos the “Mnuch” stated that “the weak dollar is good for the U.S. as it relates to trade and opportunities.” Gee thanks Mr. Secretary, but what do you guys really mean? We will tell you what it means…it means that the FED cannot have its cake and eat it too. It cannot on one hand raise rates and on the other have sit- idly by with an ever sinking U.S. Dollar.

Now all econ fundamentals aside, one should be asking, why is the dollar moving lower when our rates are moving higher. Shouldn’t that make our debt more attractive on yield a level vs another countries debt? One would think but in a central bank, in a globally coordinated central bank world you have to realize that the central banks are not working independently but in unison. We will dig deeper into that at another time, but the crux of the statement is every nation cannot be an exporter and when countries go to war with their currencies; the outcomes globally are usually disastrous and swift. Are we there yet? Yes we tend to think we are and how long the markets will continue to ignore this is anyone’s guess. Anyway the problem with the FED raising rates coupled with the U.S. fiscal support, means a whole bunch of debt is going to have to be swallowed and higher rates have to attract such unwilling participants.

The last decade will go down in the history books as the decade the central banks hijacked global financial systems and decided that it’s in everyone’s best interest to work together. That is, obviously until it is not. Who will be the first to balk? Our guess is the Chinese. They have the most to lose, domestically and internationally and it’s why they have been so reticent in shoring up their gold reserves and trying to internationalize their financial exchanges. However their underlying distrustful fiscal policies and their too good to be true WMPs, no not WMDs of the good ole Bush era, but potentially a synonymous acronym none the less as these WMPs will be like economic weapons of mass destruction. WMPs are Wealth Management Products, which basically package deposits and attract buyers with higher rates of interest, we hate to say it, but they sure do look a bit Ponzi in nature. Then again, isn’t the entire leveraged, rehypothecated, fractional reserve system, exactly just that? So let’s get to some other market news this past week:

Starbucks was out this week saying it’s going to spend $250m on new employee benefits.

Credit Suisse was out stating the Pension Funds sector should be a natural seller when it rebalances this month. No doubt equity outflows will benefit bond inflows, but in realty how big of a dent will this be?

JPM commented upon this and gave us this nice chart below. When we looked at this chart what stood out to us as odd was that the Pension Funds have flat lined their bond purchases, seems a bit odd considering the fixed payment obligations they have. This made us think pensions have been overreaching for yield for decades and in return receiving massive convexity risk. none the less we feel that if Pensions decide that equity risk is too much, we could see some massive reallocation into bonds and lower yields would beckon and equities will have a few less fools, anywhere here is the chart:

As we count down the remaining weeks of summer, we hope you enjoyed a bit of a reprieve from these markets. We hope you found some time to break away and enjoy the weather, enjoy an outdoor activity and found that there is life outside of our digital screens and everyday ups and downs of our markets. We have the luxury of beautiful Lake Michigan here in Chicago and for those looking for some nice day trips, SW Michigan offers many an amenity as does Wisconsin to our north. We like to take a break during summer and head up to Lake Geneva and enjoy one of the hidden, well not so hidden anymore gems of the Midwest. This weekend was the annual Driehaus customer appreciation party which always offers some of the best fireworks of the season, sorry Richard, I let the cat out of the bag, but you do put on a nice display. Richard is founder and manager of Driehaus Capital Mgmt here in Chicago for those wondering. Hats off to his annual fireworks display as we enjoyed some never before seen pyrotechnics, great work. It's always tough driving back to the concrete jungle but as our favorite fictional character Gordon Gekko (Wall Street 1987) always said, "Money never sleeps, pal!" So despite the FOMC week, which presented nothing out of the ordinary, the markets seem to be stuck in an ever decreasing VIX and ever increasing deterioration of the global economic indicators. As we have said time and time again, this market is centrally bank driven and thus, truly nothing else matters. The only things that seem to matter are charts like this: